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Financial Crisis

Interest rates and inflation peaked in the UK and US in 1980. Over the following 29 years interest rates declined in the US and UK from 20% to 1% generating a long uplift in the value of equities and other assets.

Japan became a global source of very cheap investment capital in the mid 90s as a consequence of ultra low-interest rates, the declining value of the Yen and the emergence of hedge funds meant that it became risk free to borrow Yen and invest in investment assets with much higher yields.

The Dow closed at under 1,000 in 1980; twenty-seven years later it reached nearly 14,000. The FTSE rose from 500 in 1980 to nearly 7,000 in 2007.

By 2000, monetary policy was being used to avert possible recessions, rather than as had been the practice, to stimulate the way out of one. This policy created additional credit, at a time when credit was already cheap and plentiful The super liquid conditions stimulated the securitization of loans by banks and the creation of many new financial derivatives outside of the control of central banks .

Inflationary consequences of the asset boom on consumer prices were absent probably because of the unprecedented productivity enhancement effects of computerization and the internet reinforced by the availability of ultra-cheap manufactured goods from China.

The point was reached where no more financial air could be blown into the bubble and it began to contract. Interest rates have now been declining for nearly thirty years, In the case of the UK and US they cannot go any lower.

The last upward cycle in interest rates began in 1950 and lasted thirty years and coincided with an era of great prosperity and growth, although the Dow ‘only’ increased 275% in those thirty years.

Here’s to the next thirty years…..

I wrote that in February 2010. What happened next?

January 2013, the credit bubble is inflating again. Worldwide, bank shares have typically doubled over the past few months. An unexceptional example is Lloyds Group whose shares were 35p in June 2012 and are now 50p i.e. Lloyds market cap has doubled to £35 billion for no discernible reason other than credit easing (mainly quantitive easing).

Junk bond yields are at an all time low, most stock markets are have risen sharply seemingly both because of credit easing – fundamental prospects haven’t changed, junk is junk, austerity is austerity, flat or declining gdp is the story in most places.

The financial establishment appear to have won enough to fight another day. Newspapers report any signs of rising property prices as ‘good’ news. Similarly more easily available consumer credit is reported as a ‘good’ story.

Let’s keep it simple. Much of the fund management ‘industry’ earns income as a percentage of assets under management – AUM. In the past six months the majority of investment assets have risen in price. The reason they have risen in unison is because of cheap and easy credit (the lowest interest rates for 300 years, mind-boggling central bank money printing via QE).

The effect of this is to sharply boost the income of financial services, a windfall which will no doubt be portrayed as the consequences of cleverness and skill (a simple lie) The resultant recovery in profits and bonuses becoming a’ good’ financial recovery story in 2014.

I know now for sure that I won’t die in my childhood, twenties, thirties, forties, fifties and early sixties. What a waste of journey time, all those hours spent contemplating cancer, stroke, heart attack, plane crashes, AIDS, Bird Flu, whole life insurance. A man of 64 has an average life expectancy of 18 years, a 50% more than the average time spent by convicts on death row in the US – 12 years.

Much seems to have happened but at the time it was just moments of the day. I was blown up once, but the explosion did a mysterious stretching thing with time, the parts never added up to the whole, I had to read it in the newspapers to experience the scale of it, even when the blood poured it did so glacially.

As a child of 8, learning history, nearly all the past seemed an incomprehensible distance. The Romans, AD 100 were near infinity. Now from the perspective of my own lifetime of 66 years, I have a graspable unit of time. I think of a date, the Copernican Revolution of 1543 for example and divide the interval, 468 years by units of my lifetime. The result – an entirely comprehensible 7 times. For my father in law who reached 92 – it was a just 5 lifetimes. 1066 is a stretch, but just about comprehensible at 14 times (10 for father-in-law).

Which leads me to how the 14.6 billion year age of the universe is now approaching comprehensibility as a result of growing familiararity with Sovereign debt numbers – the Italian national debt. 1.9€ trillion.

“Two year public sector pay freeze on staff earning more than £21,000”

Cassidy Brothers plc Chairman’s Statement:

“ Trading in 2011 is going to be difficult and will see prices rise significantly. Firstly because of the rise in V.A.T. but more importantly the impact of price rises in China and transportation and shipping costs from there to the U.K. These will affect all important price bands of £5.99 – £10.99 etc. that the consumer and trade has been accustomed to for the last ten years, most of which can no longer be maintained. The transition will take two or three years to filter through but it will happen, and any company who shuts their eyes to it will not survive. Companies have to expect negative responses from their customers and accept a decline in sales as a result. Casdon has experienced this many, many times over the past 65 years and will be prepared.”

Next plc trading statement:

“The combination of higher cotton prices, capacity tightening and a lower dollar costing rate mean that we will experience input cost price inflation in the first half of 2011. We aim to mitigate some of the effects of this with the development of new sources of supply and more rigorous negotiation. However, the combination of increasing cost prices and the January 2011 VAT rise mean that clothing retail prices are likely to rise in Spring 2011. We have yet to purchase the majority of our spring summer ranges, but we estimate that selling prices may rise between 5% and 8%.”

Interest rates and inflation peaked in the UK and US in 1980. Over the following 29 years interest rates declined in the US and UK from 20% to 1% generating a long uplift in the value of equities and other assets.

Japan became a global source of very cheap investment capital in the mid 90s as a consequence of ultra low-interest rates, the declining value of the Yen and the emergence of hedge funds meant that it became risk free to borrow Yen and invest in investment assets with much higher yields.

The Dow closed at under 1,000 in 1980; twenty-seven years later it reached nearly 14,000. The FTSE rose from 500 in 1980 to nearly 7,000 in 2007.

By 2000, monetary policy was being used to avert possible recessions, rather than as had been the practice, to stimulate the way out of one. This policy created additional credit, at a time when credit was already cheap and plentiful The super liquid conditions stimulated the securitization of loans by banks and the creation of many new financial derivatives outside of the control of central banks .

Inflationary consequences of the asset boom on consumer prices were absent probably because of the unprecedented productivity enhancement effects of computerization and the internet reinforced by the availability of ultra-cheap manufactured goods from China.

The point was reached where no more financial air could be blown into the bubble and it began to contract. Interest rates have now been declining for nearly thirty years, In the case of the UK and US they cannot go any lower.

The last upward cycle in interest rates began in 1950 and lasted thirty years and coincided with an era of great prosperity and growth, although the Dow ‘only’ increased 275% in those thirty years.

Here’s to the next thirty years…..

I wrote that in February 2010. What happened next?

January 2013, the credit bubble is inflating again. Worldwide, bank shares have typically doubled over the past few months. An unexceptional example is Lloyds Group whose shares were 35p in June 2012 and are now 50p i.e. Lloyds market cap has doubled to £35 billion for no discernible reason other than credit easing (mainly quantitive easing).

Junk bond yields are at an all time low, most stock markets are have risen sharply seemingly both because of credit easing – fundamental prospects haven’t changed, junk is junk, austerity is austerity, flat or declining gdp is the story in most places.

The financial establishment appear to have won enough to fight another day. Newspapers report any signs of rising property prices as ‘good’ news. Similarly more easily available consumer credit is reported as a ‘good’ story.

Let’s keep it simple. Much of the fund management ‘industry’ earns income as a percentage of assets under management – AUM. In the past six months the majority of investment assets have risen in price. The reason they have risen in unison is because of cheap and easy credit (the lowest interest rates for 300 years, mind-boggling central bank money printing via QE).

The effect of this is to sharply boost the income of financial services, a windfall which will no doubt be portrayed as the consequences of cleverness and skill (a simple lie) The resultant recovery in profits and bonuses becoming a’ good’ financial recovery story in 2014.

“In the UK interest rate cuts since the start of the crisis have delivered the average £103,000 floating rate mortgage holder an annual saving of £4,635.Against that the government estimates the net cost of bailing out the financial system at £10bn or £400 per household.” Lex in the Financial Times today.

There are 26m households in the UK.

But only 11.1m of households have a mortgage and of those, only 55%, or 6 million, are on variable rates.

In other words 100% of households paid £400, but only 23% received savings of £4,635.

Plus all households shared (via pension and other indirect and direct holdings), in the loss of £5bn of dividend income from Royal Bank of Scotland (£3bn dividends in 2007, nil in 2009) and Lloyds (£2bn dividends in 2007, nil in 2009) = £192 per household.

All households via pension other indirect and direct holdings, shared in the loss of billions of market value of the UK quoted bank sector. The £30bn loss of market value of Royal Bank of Scotland alone amounted to £1,150 for every household.

So without really trying I am already up to £1,742 for every household.

Is Lex spinning or being economical with the truth?

Who gains from the gross misrepresentation of the facts?

Follow the money?

Lex, care to calculate what the total reduction in the value of UK bank shares was, divided by households? Who do you think bore that cost? Maybe you need new batteries for your calculator?

Bun rating – Zero, too much smoke and too many mirrors to see if there is a pattie

Why do we deride crystal ball gazing, palm reading, and even (some of us), astrology, and yet base our investment decisions on the predictions of financial analysts? How accurate are forecasts? Why should we believe that one specific area of futurology is a science? And how much forecasting is really being done?

Quoted companies are under an obligation not to knowingly allow a false market to develop in their shares. In practise this means that they issue frequent statements about current trading and outlook, and sometimes even issue a specific statement if they need to correct an over optimistic or pessimistic consensual view of their trading performance.

This means that if you are a financial analyst making a bad guess, you will have your work corrected in time to stop you looking foolish. Here are a couple of examples out of many:

Which illustrious broker said of Barratt Developments in May last year when the share price was 177p “hold, price target 302p” and in May this year “sell, target 75p” when the price was 105p, and in September “hold, target 172p when the price was 172p?

Or which major international financial institution said of Land Securities in June 2007 whent he share price was 1557p “Buy, target 2250p”, and in November of the same year when the share price was 1400p “Buy, target 1735p”? The same institution that said in July 2009 when the price was 500p “Hold, target 500p” and last month when the price was 530p “Neutral, target 645p.

Land Securities share price closed at 725p yesterday- 13th November !

If analysts can continuously adjust their estimates of earnings to reflect changed actual conditions as they become apparent, what forecasting is being done? What is the difference between continuously updated forecasting and a continuously changing share price?

Ordinary mortals can’t place bets on a race once it has begun. The analysis game is different. Analysts can keep switching their bets to the horse most likely to win, right up until the last few furlongs, and then claim credit for prescience.

“We, the G20 Finance Ministers and Central Bank Governors, reaffirmed our commitment to strengthen the financial system to prevent the build-up of excessive risk and future crises and support sustainable growth.” From the communiqué issued this weekend.

“In finance, the financial system is the system that allows the transfer of money between savers and borrowers”. Wikipedia

But the financial system being strengthened is no longer just a system that “that allows the transfer of money between savers and borrowers”

It is now also a system in which banks rely upon creating derivative instruments to maintain substantial profitability. The “transfer of money between savers and borrowers”, does not depend upon the existence of derivative intruments and other complexities for its execution. Money has been transferred efficiently between savers and borrowers for centuries without the intermediation of recent innovative fee absorbing structures, which are more akin to a new tax on the transfer of money.

A typical example is an interest rate hedge, the manifest purpose of which is to allow one party to hedge i.e. to insure against a damaging change in interest rates over a defined period. A property investment company buying a property yielding 8 % with a variable interest rate loan commencing at 5% might decide to lock into the 3% differential by purchasing a derivative contract should interest rates increase to say, 9%. It would do this if it thought interest rates were more likely to increase than decline over the period.

In recent years, many finance directors of quoted companies have taken a view, i.e. decided they have a better idea than the market, of the movement in future interest rates and hedged the interest rates on their borrowings accordingly. Most property companies which took out interest rate swaps did so to protect themselves from what was perceived to be the risk of interest rates rising in the future.

A call on interest rates, is a call on interest rates. You can’t hedge yourself out of the financial pain of being wrong by taking out an interest rate hedge, because taking out a hedge is taking a position on future interest rates, which are unpredictable.

Now because their guesses were wrong (instead of increasing, interest rates declined to the lowest levels in decades), huge liabilities have been created in the balance sheet of these property companies, in some cases sufficient to threaten their solvency or independence. An examination of the latest balance sheet from Brixton plc (BXTN) will show what can happen!

It isn’t quite a zero sum game though, for the creators of the hedges, it is a money spinner whether the roulette ball falls on red or black.